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Ross Private Equity Conference Preaches Adaptability

10/8/2012 --

Industry giants Sam Zell and Steve Klinksy headlined the seventh-annual event.

ANN ARBOR, Mich. — Private equity is based on predicting the future. But how do you adapt when the future is so uncertain?

Such was a central question permeating the seventh annual Michigan Private Equity Conference, hosted on Oct. 5 by the Ross School of Business, the Samuel Zell & Robert H. Lurie Institute for Entrepreneurial Studies, and the Michigan Private Equity Partnership Alumni Club.

"There have never been more headwinds, and there has never been more uncertainty, at any other point in my career," said Sam Zell, AB '63/JD '66/HLLD '05, who kicked off the conference with a keynote address. The founder and chairman of Chicago-based Equity Group Investments pointed to the upcoming U.S. presidential election, political unrest in the Middle East (including increasing U.S. tensions with Iran), the looming Jan. 1 tax increases, and the financial crisis in the Euro zone as key sources of anxiety.

"No matter who is elected [president] in November, 2013 is going to be challenging," Zell said. "How we in private equity act will depend on who's elected, but the time has come to act, regardless."

Increased government regulation and a policy of "flooding the market with money no one wants, except those who can't pay it back" are radically affecting the future possibilities of the investing business, said Zell. And he cautioned that investors shouldn't be placated by the rebound of the U.S. stock market. "It's not an indicator of reality. There are huge distortions."

While the U.S. domestic economy faces an uncertain future, Zell said Europe faces a possible economic depression. "The first rule of private equity is that you don't cut a deal unless you have an exit strategy," he said. "The whole Euro system was created without an exit strategy. This is not an incremental problem — it's a systemic risk. So how do private equity firms underwrite deals involving Europe these days? I don't know."

Zell also pointed to stalled growth in China, India, and Brazil over the past five years. "Is this a falling knife we're trying to catch, or is it restabilizing?" While everyone is betting on tomorrow being better, it's hard to underwrite deals without growth, he argued.

So how do private equity firms stay ahead? By being adaptable, said Zell. He thinks growth markets will recover within five years, but acknowledged, "Five years is a long time." He urged participants to show greater focus on the system and its risks relating to leverage. "If we finance something today, we ought to be thinking about amortization. The risks to the buyer versus the risks to the seller are out of kilter."

Panels featured representatives from both the buyers' side and sellers' side of private equity, and explored such topics as operations improvement, the role of limited partners, and how PE firms create value in portfolio companies.

Ed Hightower, MBA '95, managing director of Motoring Ventures LLC, said one key to success in today's uncertain economy is to closely examine a company's growth strategy and whether or not its cost structure supports it. "As Sam [Zell] said, private equity is based on the assumption of future growth. Companies should understand their cost structure down to the granular level so they can identify process improvements that could lead to growth. Everyone has differing views on growth — your cost accountants should be your referees."

It's also important to consider a company's track record, said Miguel Gonzalo of Adams Street Partners. "Look backward to predict the future. See who's stuck to their discipline. As private equity is becoming more specialized, we're looking for repeatability."

In his keynote address, New Mountain Capital LLC's managing director, founder, and CEO Steve Klinsky, AB '76, said staying the course is one reason his company earns consistently high returns. Klinsky was co-founder of Goldman Sachs' leveraged buyout group in the early 1980s and launched New York-based New Mountain in the late '90s. "We've had the same strategy since we began," he said, "which is to proactively pick defensive growth niches that can grow regardless of current conditions."

Klinsky acknowledged that the "Romney Effect" has put private equity in the hot seat, but touted the important impact the industry has on the global economy. "Private equity is a positive thing. People don't realize how prevalent it is, how many companies are owned by private equity firms. Part of it is making people aware of what we do and that we're not the bad guys."

"What we are going through is good for the industry," Zell said. "As in 2008, the notion of the survival of the fittest will prevail."

— Amy Spooner



For more information, contact:
Amy Spooner, (734) 615-5068, aschulz@umich.edu